Industrial equipment manufacturers (OEMs) are encountering intensified competition and product standardization, which result in dwindling prices and squeezed margins. Consequently, they face difficulties sustaining growth and meeting operating profit expectations through product revenues alone. To tackle these issues, companies are broadening their scope to incorporate value-added services like performance-based and outcome-based service contracts, allowing them to achieve increased operating profits, competitive distinction, and enhanced customer focus.
Conversations with some of our clients, who represent leading industrial equipment manufacturers, reveal that their customers are progressively requesting advanced service contracts that cover the services provided by the products, rather than simply purchasing the products themselves. Customers prefer not to own or manage their devices, choosing instead to delegate the management of their assets to original equipment providers or third-party service providers. Digital advancements and Industry 4.0 are creating new possibilities for offering more services and implementing outcome-based business models, such as pay-for-performance, outcome, and availability. These supplementary services can be profitable, generating high gross margins while promoting increased customer loyalty.
Expanding the service portfolio and successfully transitioning from products to services
The shift from products to services and broadening the service portfolio to include outcome-based solutions carries risks. Companies must exercise caution when transitioning too quickly from conventional services like repair and maintenance to more value-added services, such as financing, long-term service contracts, and outcome-based solutions. Failing to deliver these services can have negative implications for a company's brand, reputation, and financial standing.
Successful companies initiate by developing new services with their most trusted customers and showcasing results before rapidly scaling (i.e., soft launch). They often start by providing limited services based on customer demand, concentrating on extending the product lifecycle. Service leaders acknowledge the need to cultivate their services as a separate business line, creating distinct P&L responsibilities and allocating resources to marketing, sales, operations, and R&D for a unique service strategy.
For a successful transition, crucial capabilities in innovation, commercialization, and service delivery are required. Expanding the service portfolio through innovation demands a customer-centric approach from concept to execution, with a focus on speed, scale, cross-functionality within the organization, and open collaboration with partners, investors, and suppliers.
Selling services necessitates a shift in commercialization capabilities, emphasizing value selling. Selling outcome-based services typically involves longer sales cycles and engages a wider, more senior group of customer stakeholders. Service delivery is critical to success, and companies must establish capabilities across core processes such as customer management, service supply chain, service operations, partner management, engineering, and digital enablement to become a 'service leader.'
Examples of industrial manufacturing companies successfully transitioning from products to services include Atlas Copco's FleetLink management system, which enables remote monitoring of construction equipment and sends servicing notifications to asset owners. Philips' intelligent lighting solutions offer efficient energy monitoring, allowing for increased customization and reduced energy consumption. Wind turbine manufacturer Vestas provides active output management (AOM) solutions with flexible service contracts tailored to customer needs and return on investment expectations. AutoStore's Pay-Per-Pick service lowers upfront investment while allowing customers to pay only for the services they can generate revenue for, ultimately enabling smaller businesses to benefit from advanced robotic technologies for warehousing and fulfillment management.
All in all, industrial manufacturing companies need to proactively adopt market research, stakeholder engagement, and change management practices to ensure a seamless transition from selling products to selling services. Adopting hybrid models and subscription-based models can offer effective ways to mitigate risks and capitalize on new opportunities. By carefully managing and mitigating the risks associated with this transformation, companies can seize the opportunities presented by the service-based business model and flourish in an increasingly competitive and dynamic market.
Nevertheless, when businesses undertake the shift from a product-focused model to a service-driven one, they will unavoidably face a range of risks and obstacles. It's essential for companies to recognize these risks and develop plans to address them effectively. In the following section, we offer a brief Risk Management Guide that highlights several primary risks that companies might encounter throughout this transition, as well as some actionable mitigation approaches to support a successful transformation.
A brief Risk Management Guide for planning a transition from a product-oriented business to a services-oriented one
1. Organizational Culture and Mindset: Switching from a product-centric to a service-centric approach requires significant changes in organizational culture and mindset. Employees may need retraining or upskilling to deliver services effectively, and resistance to change can be a major hurdle.
Mitigation Strategy: Implement strong change management practices, engage stakeholders in the transition process, and invest in ongoing employee training and development to cultivate a service-centric mindset.
2. Financial Risks: Transitioning to a service-based model can impact cash flow, particularly in the initial stages, as companies move from one-time sales to recurring revenue streams. This can affect cash flow, especially during the early stages of the transition, making financial planning and forecasting critical for managing potential revenue fluctuations and ensuring that the company's cash reserves can withstand the transformation period.
Mitigation Strategy: Develop a comprehensive financial plan that accounts for the shift in revenue streams and closely monitors cash flow and cash reserves during the transition period.
3. Customer Perception: Existing customers may perceive the company as inexperienced or unqualified to deliver services, affecting the company's reputation in the service domain.
Mitigation Strategy: Communicate the value proposition effectively, showcase success stories, and leverage customer testimonials to build credibility. Consider starting with a soft launch of a few services with a select group of close customers, building credibility through their experiences, and modifying your offerings based on the feedback from the soft launch.
4. Competition: The service market might be more competitive, with established players already offering similar services. Differentiating offerings and identifying niche segments become essential for gaining a competitive edge.
Mitigation Strategy: Conduct thorough market research to identify gaps in the market, leverage the company's unique strengths, and develop innovative service offerings that set the company apart from competitors.
5. Operational Challenges: Delivering services efficiently and reliably requires managing complex logistics & supply chains, service teams, and field agent schedules, dealer relations, and customer support systems.
Mitigation Strategy: Invest in the necessary infrastructure, develop new capabilities, and establish strategic partnerships to address operational challenges.
6. Intellectual Property (IP) and Legal Risks: Transitioning to a service-based business model may expose the company to new IP and legal risks.
Mitigation Strategy: Protect proprietary knowledge, and trade secrets, and ensure compliance with relevant regulations by developing robust legal and compliance frameworks.
7. Scalability: Services often require a higher level of customization and personalization, which can be challenging to scale.
Mitigation Strategy: Find the right balance between customization and standardization to maintain profitability while providing value to customers.
8. Talent Acquisition and Retention: A services-oriented company may need a different skill set than a product-oriented one.
Mitigation Strategy: Attract, develop, and retain the right talent to support the new business model through targeted recruitment, training, and employee engagement initiatives.
9. Technological Risks: Adopting new technologies to support service offerings can involve significant upfront costs and risks associated with technology adoption and integration.
Mitigation Strategy: Conduct a thorough technology assessment, invest in pilot projects to test new technologies, and develop a phased approach to technology adoption.
10. Quality Control: Ensuring consistent quality across all service offerings is crucial for maintaining customer satisfaction and trust.
Mitigation Strategy: Establish robust quality control processes and systems, and invest in continuous improvement initiatives to maintain high-quality standards. Never promise more than what your service team can deliver. With service businesses, compared to selling products, it is harder to recover from the damage to customers' trust if you fail to deliver on what you have promised.